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Deeds of variation

With the advent of autumn,the tax adviser&#39s thoughts turn towards what might be contained within the Chancellor of the Exchequer&#39s pre-Budget statement which is due at around the end of November and, ultimately, the possible contents of the Budget itself in the spring.

No matter what is contained in any possible new legislation, one of the bedrocks of any financial planning exercise for clients will be to ensure that an appropriately written will is in place.

However, even if this is the case, there may be reasons why the beneficiaries of such a will may want to re-arrange or vary the disposition of the deceased&#39s estate on his death by the use of a deed of variation.

Provided the deed of variation is executed within two years of the death of the deceased, the arrangement would be treated as a disposition by him for inheritance tax purposes and this type of planning would be particularly appropriate where, for example, a husband predeceases his wife leaving all his estate to her.

She then realises that he has effectively wasted his £255,000 nil-rate band and so can rectify this situation by executing a deed of variation redirecting assets direct to her children or grandchildren.

Of course, any access to capital redirected in this way will be lost. As an alternative, the widow could consider creating a settlement under the deed of variation.

If a discretionary trust is utilised, the widow, although not absolutely entitled to any income arising, could be regarded by the trustees as the prime beneficiary of such income.

In addition, the trust could be drafted so as to enable advancements of capital to be made if necessary.

However, it is important to realise that, although the varying of the legacy to the discretionary trust would be treated as a disposition by the deceased for inheritance tax purposes, the widow (having given up her absolute entitlement) would be treated as the settlor of the trust for income tax and capital gains purposes.

The implications of this would be that any income arising under the trust would be assessed on the widow and any capital gains arising would also be deemed to be the widow&#39s capital gains (although her annual capital gains tax exemption should be available to set off against such gains). Similarly, if a trust should be created for the benefit of the widow&#39s unmarried minor children, once any trust income exceeds £100, it will all be assessed on the widow herself.

It might therefore be attractive if this type of planning is being considered, to invest in a non-income-producing asset such as a single-premium bond to avoid some of these potential pitfalls, although it should be borne in mind that, on the occurrence of a chargeable event, any tax charge will be based on the income of the widow as settlor – assuming, of course, that she is still alive and resident in the UK at the date of any such chargeable event.

The capital gains tax implications of utilising a deed of variation should also be borne in mind.

The simplification of the rules with effect from August 1, 2002 enables the appropriate elections for both inheritance tax and capital gains tax to be made within the deed of variation itself.

If an election is not made, the deed will be treated as a disposal for capital gains tax purposes by the person who is giving up their right to property.

Generally, for capital gains tax there is an exemption on death and an uplift to market value. Accordingly, it may not always be appropriate to elect for both taxes.

It may be advantageous to elect for inheritance tax but not for capital gains tax if, for example, there are assets with losses, the capital gains tax annual exemption is available or if non-UK residents are involved.

Finally, it should be borne in mind that it is possible to vary assets that were held subject to a joint tenancy (despite the fact that it is not possible to sever a joint tenancy under a will).

It is also possible to vary an intestacy situation (so long as the persons concerned are of full age and legally capable) and it is even possible to execute a “double-death” variation if both spouses have died within the two-year period.

It can be seen that deeds of variation remain a very important tool in the tax planner&#39s armoury but it should, of course, always be borne in mind that it is preferable to sort all these issues out while the testator is still alive and can take part in the process.


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